Investing

What will you do with your RRSP when you turn 71?

By Anne Levy-Ward

Planning for retirement? You might know about the deadline for closing your RRSP. But do you know what you’ll do with your money then?

Maybe you’ve been saving in your registered retirement savings plan (RRSP) for decades, or maybe you only started in recent years, once the mortgage was paid and the nest emptied. But either way, there’s a RRSP deadline looming in your future, and it’s not the 1st of March: By the end of the year you turn 71, you are required by law to close down your RRSP.

What will you do with your RRSP money? Just as it took you years of discipline to save it, you’ll want to take a long-term, disciplined approach to spending it.

You have 4 main options:

Take it in cash

Purchase an annuity

Put it into a registered retirement income fund (RRIF)

Some combination of the above

Before you decide which route to take, it’s important to get all the facts plus some expert advice, because once you’ve committed to an option, you may not be able to change your mind.

Taking the cash

Let’s get this one out of the way immediately. Any money you take out of your RRSP (unless it’s to buy a first home under the Home Buyers’ Plan or to go back to school under the Lifelong Learning Plan) is considered taxable income. Assuming you have a fairly significant amount in your RRSP by the time you reach 71, if you cash it all out you’ll have to pay substantial income tax – perhaps even more than you would have paid back in your earning years if you hadn’t contributed to an RRSP in the first place. This is, therefore, not the recommended route to take. If you really, really need to access some of that cash for something vital, like renovating your home to make it wheelchair-accessible, talk to your advisor about the most tax-efficient way to do it.

Buying an annuity

A life annuity is the best way to protect yourself against the risk of outliving your money. It works like this: You pay a life insurance company a lump sum, and in exchange you get a guaranteed income for life, paying tax on the income as you receive it. There are some important variables to consider when buying an annuity. Generally speaking, the longer the guaranteed period (or the younger you are when you buy a life annuity) and the more additional guarantees (like indexing or continuing payments to your spouse after your death) included, the lower the annual income you will receive in exchange for a given lump sum. (To estimate the income you can receive from a life annuity, try our annuity calculator.)

The other major factor that affects annuity payments is beyond your control: long-term interest rates. These affect what the insurance company can expect to earn by investing your money. The insurance company takes future investment income into account when it establishes the amount of income you can buy with a given lump sum. The income is fully guaranteed when you sign an annuity contract, so future fluctuations in rates won’t affect the income you’ll receive. If equity markets tumble or long-term interest rates crater, your payments won’t decrease – but they also won’t increase if markets or interest rates go through the roof.

Putting your money into a RRIF

Let’s start with a clarification: A registered retirement income fund isn’t always an investment as such, like a guaranteed investment certificate or a mutual fund. Often, it’s a type of registered plan, like an RRSP, that can contain various kinds of investments (which could include, among others, GICs or mutual funds), tax-deferred. But sometimes, such as when you buy a segregated fund contract from an insurance company, the contract IS the RRIF. And rather than sheltering the growth of your investments from tax while you’re saving for retirement as in an RRSP, a RRIF shelters your investment growth during your retirement. It also allows you to spread out the income tax bite over the time it takes you to draw it down.

Rolling your RRSP money into a RRIF means your money can continue to grow, even while you’re tapping it for income. But because the government won’t let you put off your tax bill indefinitely, there’s a catch: You must by law withdraw an increasing minimum percentage of the value of your RRIF each year, whether you need the money or not. At the moment, the minimum withdrawal factor is 5.28% at age 71. It rises gradually, reaching 10.21% at age 88 and topping out at 20% at age 95. The percentage you have to take out for any given year is calculated using the fund value and your age, both as of January 1 for the year of your withdrawal.

You must take out the annual minimum payment by December 31 of the year following the year you establish your RRIF, which gives your investments a bit more time to grow undisturbed

A RRIF gives you the flexibility to take out more income when you need it. But you should work out whether you can do so and still have your RRIF last as long as you need it to. In addition, if you have a spouse or common-law partner who’s younger than you, you can make your RRIF last longer by basing your withdrawals on that person’s age. You can also pass your RRIF on after your death without triggering a tax bill by making your spouse or common-law partner the successor annuitant.

How to decide what’s right for you

This is clearly a case where expert advice can be invaluable, as you’ll need to weigh your desire for a guarantee against your need for flexibility. Many advisors recommend a combined approach: Use some of your RRSP savings to buy an annuity that will pay you enough to cover fixed expenses like food and housing, and put the rest in a RRIF to pay for more discretionary spending.

“Splitting your RRSP money into a RRIF and life annuity can provide the best of both retirement income worlds,” says Melanie Johannink,1 a Sun Life Financial advisor based in Vaughan, Ontario. “You get growth potential and guarantees.”

“Combining an annuity and a RRIF might best fit your budget and lifestyle,” she says. “That way, you have the option of taking out the minimum some years and more in other years, with the peace of mind of knowing that your annuity will pay for your basic living expenses. You should also look at using a tax-free savings account as part of your retirement planning.”

Toronto-based Sun Life Financial advisor Brian Burlacoff2 also believes in the wisdom of a dual approach. “With a RRIF, there’s a lot of flexibility when it comes to how fast you spend your money,” he says. “But you may be willing to give up some of that flexibility for the guarantees you get with an annuity. With a RRIF in mutual funds, you bear the risk; with an annuity, the risk is on the insurance company that issues it.”

You can combine an annuity with your CPP, Old Age Security and defined-benefit pension (if you have one) payments to cover life’s necessities, he suggests, and use a RRIF to pay for more discretionary items like travel. “And the year the investments in your RRIF don’t perform as well, you can put off discretionary spending,” he says.

Burlacoff points out that the income you expect to receive from a RRIF and/or an annuity comes with 2 important caveats. “When you’re planning your retirement, you have to keep in mind that there are 2 people who own your money before you do: the tax person and the inflation person,” he says. “Remember that your retirement savings will be reduced by both income tax and the effects of inflation – and build that into your plan.”